Defaults and Returns on High Yield Bonds: Analysis Through 2001
NYU Salomon Center Working Paper No. S-02-4
Posted: 1 Apr 2002
Date Written: January 2002
The year 2001 was remarkable on many fronts. For the high yield market, it was a year of crushing record numbers of defaults and distressed exchanges, combined with predictable low recovery rates. Despite these fundamental problems, and the "flight to quality" following the terrorist attacks in September, the high yield market displayed impressive resiliency and confidence going forward. Returns were positive and quite good relative to most other asset classes and high yield new issuance was buoyant, approaching $90 billion.
Default amounts registered its third consecutive record year and topped $60 billion, more than double the previous high of $30 billion in 2000. The default rate was 9.80%, just below the record years of 1990 and 1991. Combined with a near record low recovery rate of 25 cents on the dollar, including the unusual FINOVA default, and about 21 cents without FINOVA, loss rates from defaults were about 7.76%, again second only to 1990's rate.
This report documents and comments upon the high yield bond market's risk and return performance by presenting traditional and mortality rate statistics and providing a matrix of performance data over the market's history. Our analysis covers the period 1971-2001 for most defaults and the 1978-2001 period for returns. In addition, we present our annual forecast of expected defaults. Last year, 2001, we originally expected about a 7.0% default rate and revised our forecast to 9.6% as the year's events unfolded. For 2002, we are predicting a 7.0-8.0% rate, still quite above average but below the 2001 rate. Again, the major uncertainty is the nation's economic performance.
Finally, in this report we introduce two new innovations in our analysis of the high yield bond market. We adjust our traditional measure of default loss rates by factoring in the impact of fallen angel defaults where the "investment" in these issues is typically much below par value. We also summarize some recently completed work on analyzing default recovery rates, with an econometric model that has explained over 90% of the variation in recoveries over the last two decades and was dead-on in predicting the recovery rate in 2001.
JEL Classification: G15, G21, G28
Suggested Citation: Suggested Citation